Prior Year Method First Plan Year

[Dougsbpc]

A 401(k) plan is first effective in 2007 (calendar year plan) and uses the prior year testing method.

This is a sole proprietor so the proprietor has not yet made his salary deferrals for 2007.

There is one HCE and one NHCE eligible in 2007. The HCE makes maximum salary deferrals and the NHCE makes no salary deferrals.

We are allowed to use 5% as the maximum HCE deferral rate for 2007 under the prior year testing method for the first year.

It appears QNECs can be made using the prior year method as long as they are contributed within one year of the applicable year. The applicable year would be 2006 even though the plan did not exist in 2006.

The employer did make an employer contribution more than 2% prior to 12/31/2007.

Question: can a 2% QNEC be allocated to the NHCE for 2007 therby allowing the HCE to defer 7%?

Thanks much

[Tom Poje]

well it sounds possible, but...

on what comp are you figuring the 2%? the prior year?

while it shouldn't be a problem with NHCEs, is there a 415 limit issue? I am assuming the 'QNEC' was deposited 30 days after the taxable deadline for the 'prior' plan year.

you may have a(4) testing to do - one with QNECs and one without QNECs.

interesting, Notice 98-1 says you can use 'prior year testing' and yet use current year data the first instead of the 3%. OI hadn't relized that.guess that depends on how you write your document.

[Dougsbpc]

Thanks Tom.

The employer funded about 3% of comp in December 2007. Since this is past 30 days after the taxable deadline for 2006, this amount would be an annual addition for 2007. However, that is not a 415 problem for the NHCE.

The real question has to do with whether the QNEC could be used. Our understanding is that the QNEC must be allocated for the prior plan year, even though it can be contributed up to one year later. So the 2% QNEC would have to be allocated as of 12/31/2006 even though it is contributed in December 2007. That is fine for an on-going plan, but this plan did not exist as 12/31/06.

[rcline46]

This still falls under prior year testing and they had to choose either 3% or current year before the end of the year. Under prior year testing you can deposit a QNEC before the end of the current year which can be used to be added to the ACTUAL prior number, which is -0-.

If you chose the current year, then you get a QNEC to add to the current deferral rate, which again is -0-. The 3% number is useless if you are using a QNEC - read the QNEC rules.

I would like to see the enrollment form for the NCE where they elected not to defer. CHances are high there is no form and the employee was never given an option. Limit the HCE to 5% if he choose that option and let it go.